Tata Comm: Upsides in stock limited given execution challenges, valuations

Sharp rally and integration/execution challenges may cap upsides for the stock

After a strong rally since mid-May, the Tata Communications stock has shed over 3 per cent in the last few sessions. While the recent acquisition of US-based and NYSE-listed Kaleyra comes at a reasonable price and is expected to strengthen its portfolio, brokerages believe the upsides in the stock are limited given execution challenges and high valuations.

The cash consideration of the deal to buy the Communications Platform as a Service or CPaaS player is $100 million or Rs 820 crore and is payable to shareholders of Kaleyra at $7.25 a share, a 59 per cent premium to the prices prior to the announcement. With the enterprise value (EV) of the deal at $250 million (Kaleyra has a debt of $150 million), valuations (EV/sales) at 0.76 times on CY22 numbers are reasonable.  

The lower valuation is due to the fact that the acquired entity made a loss at the operating level of $15 million for CY22. Though it turned profitable in the March quarter this year due to cost rationalisation measures, its adjusted operating profit margin was half that of peers.

While Tata Communications highlighted that it would focus on achieving breakeven (of acquired entity) at the operating profit level in the near term and improve the same to double digits in the medium term on the back of synergies and ongoing value creation programme, Emkay Research highlights that a lot will depend on execution to drive synergies.

The acquisition will, however, improve its position in key markets such as the US, which is Kaleyra’s largest market accounting for 39 per cent of its revenues. The other major markets are India (21 per cent) and Italy (19 per cent). Kaleyra’s industry-proven platform, inter-connect, scale and capabilities would help Tata Communications ramp up its offerings in the fast-growing CPaaS space, say Aditya Bansal and Anil Sharma of Kotak Research. The segment is expected to exhibit a growth of 22 per cent annually over the FY2022-27 period.

The acquisition could also help the company achieve its goal of doubling data revenues by 2027. Santosh Sinha and Inaara Bardai of Emkay Research believe that the company will have to grow its revenues by 15 per cent annually (over FY25-27, post acquisition) to hit its data revenue target of Rs 28,000 crore by FY27. The brokerage has a 'hold' rating on the stock. The acquisition, however, could dilute the margins of Tata Communications to 21-22 per cent assuming Kaleyra’s margins of 0-7 per cent. The operating profit margins of Tata Communications were in the 24.2-25.3 per cent band over the last three financial years.

Kotak Research believes that growth for the merged entity could accelerate with the company’s large enterprise customer base and there is significant room for margin improvement. The brokerage, however, has a 'reduce' rating on the stock given rich valuations post the recent run-up. Since mid-May, the stock is up 26 per cent.